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Abenomics: the Perils of Success

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Published in Newsweek Japan 1/10/2013

The biggest risk to Abenomics is too much success too soon – leading to complacency and misjudgements. The premature hike in the consumption tax is one example. Excessive reliance on public works projects could be another.

Napoleon is supposed to have said that the most important quality in a general was not talent or courage, but luck. He would surely have approved of the Japanese prime minister .

From former Prime Minister Noda to independent populist Toru Hashimoto, one by one Mr. Abe’s opponents have collapsed like marionettes with their strings cut.

The gods of fortune smiled on Tokyo’s Olympic bid too. A few years ago, when the BRICs hype was in full cry, the global mood might have favoured Istanbul.

Since then the emerging world has witnessed disturbing scenes of political instability, structural corruption and ethnic and religious strife. All of which comes as a salutary reminder that  few rising economies have gone the distance and attained the living standards of the wealthiest countries.

Japan remains the paragon of those that did.

Tokyo 2020 sets the seal on an unbroken run of success for Abenomics. It also provides an outlet for Japan’s national pride likely to prove less contentious and a lot more fun than visits to Yasukuni Shrine.

For Mr. Abe and his party the Olympics fulfils another useful purpose – providing justification for all kinds of public works projects and infrastructure upgrades. The good times are about to start rolling again for the construction industry, producers of cement and structural steel and of course the jiage-ya land sharks.

The only problem is that Japan already has more than enough infrastructure. According to a recent study by McKinsey, Japan possesses a stock of infrastructure equivalent to 180% of GDP, more than double the average of the other countries surveyed.

This is not the Showa high growth period and economic policy cannot be an exercise in nostalgia.

These days the Olympics is not just a sporting occasion, but an opportunity to project soft power to a huge global audience. Hopefully the Japan that greets the world at the opening ceremony in 2020 will be neither a back-from-dead “construction state”  nor the stereotypical “beautiful country” peddled by Mr Abe in his first term, but something surprising, quirky and heterogenous.

Back at street level in 2013, Abenomics is producing some results. Land prices are on the move. The auto industry is roaring back to peak profitability. There are even a few signs of inflation – such as Yakult raising prices on its probiotic drinks for the first time in twenty two years. Meanwhile the launch of NISA tax-free investment accounts is going well, with over three million opened already.

The change in the psychological weather is evident in the new tone taken by some weekly magazines, which are carrying predictions of boom times ahead rather than the usual blood-curdling visions of economic collapse. Negativity appears to be going out of fashion. That is probably the biggest achievement of Abenomics so far.

Yet these are still very early days; generating 3% nominal GDP growth on a sustainable basis will be no easy matter. There is a record-high gap in profitability between the large company sector, which has benefitted hugely from the weaker yen, and the small companies which employ 70% of the workforce. No surprise that wages and retail sales have yet to show much signs of life.

Even in the buoyant stock market, the main buyers this year have been foreign investors. Japanese institutions and the huge pools of capital they control remain risk-averse and passive.

As for the wage hikes that Mr. Abe is hoping to encourage, supply and demand for labour is not yet tight enough to make that a sustainable reality. Over the past fifteen years, Japan’s workforce participation ratio has fall from 63% to 58%, meaning that real unemployment is more than double the official measure.

Recent developments in the United States highlight the difficulty of generating economic momentum in today’s world. After an extended period of aggressive QE (quantitative easing), the American economy appeared to be on a strong enough footing to justify winding down the strategy. Federal Reserve Chairman Bernanke signalled as much in a number of carefully worded pronouncements.

In the end, though, a succession of weak data forced him to call off the tapering. Specifically, growth in employment and incomes remains feeble and consumer price inflation of just 1% is well below the level that Bernanke was targeting.

In Japan, the challenge is likely to be much greater. Not since 1992 has Japanese inflation reached the Bank of Japan’s current target of 2%. Anyone under forty years old has spent their entire working lives in a world of falling real estate prices, stagnant wages and shrinking horizons. Deflation is entrenched in the economic system and in people’s minds.

Abenomics has a paradox at its heart. It can only work if people believe it is going to work. Converting the deflationary psychology into a reflationary psychology; leading the Japanese public from fear of the future to confidence in brighter prospects; coaxing super-conservative investors to shift from cash and bonds to stocks and real estate – all this is part of a delicate psychological operation which is as difficult as getting pandas to mate.

The mood has to be absolutely right. There should be no distractions. And even if everything goes well, it’s going to take a long, long time.

Given this background, a large hike in the consumption tax after just one year of Abenomics is a blunder – equivalent to throwing a bucket of cold water on a shy panda couple just as they start to rub noses.

As we have seen in the United States and the UK, monetary stimulus is less effective when fiscal policy is contractionary. Attempting to offset the decline in demand through tax incentives for increased capital spending is understandable, but still a retrograde step. Historically the Japanese corporate sector has invested too much – which is why the return on assets is so low by international standards.

For the first time, the Abe administration is mixing its messages . To encourage a reflationary mindset, growth has to be viewed as the single, overriding priority. Giving equal billing to fiscal austerity confuses the issue. And if the fiscal situation is really so dire, where is all the money coming from for corporate tax breaks and public works?

“Buy my Abenomics”, Mr. Abe said recently on the floor of the New York stock exchange. So far his policies have been great for the financial markets and that could well remain the case. The Bank of Japan will likely respond to the coming erosion of purchasing power by ramping up the monetary stimulus, probably weakening the yen in the process. And more money sloshing around the system is always welcome to financial markets.

But politically Abenomics will not have a long term future unless it is a “buy” for consumers and employees of smaller enterprises too. If the main beneficiaries are seen to be large exporters and foreign investors, dissatisfaction will mount and Mr. Abe’s support base will gradually crumble.

As Napoleon himself found out, no lucky streak lasts forever. Mr. Abe needs his to continue if he is to negotiate the more challenging landscape ahead.